Chartered Financial Analyst (CFA) Level 1 Practice Exam

Which method is appropriate for calculating the cash flow available to all capital providers?

1. Free cash flow to equity

2. Free cash flow to the firm

3. Operating cash flow

4. Net cash flow

The correct answer is: Free cash flow to the firm

The appropriate method for calculating the cash flow available to all capital providers is the measure known as Free Cash Flow to the Firm (FCFF). This metric represents the cash generated by a company's operations that is available to both debt and equity holders. FCFF is calculated by taking the operating cash flow and adjusting it for capital expenditures and changes in working capital, while also considering taxes. The significance of FCFF lies in its comprehensive nature; it provides insight into the total cash flow generated by the firm that can be used to repay creditors, reinvest in the business, or distribute to shareholders. This makes it an essential metric for assessing the overall financial health and viability of the firm from the perspective of all capital providers. In contrast, Free Cash Flow to Equity specifically focuses on the cash available to equity shareholders after accounting for all expenses, reinvestments, and debt repayments. Operating cash flow represents the cash generated from daily business operations, without considering capital expenditures or the financing activities of the firm. Net cash flow usually reflects the overall cash movement in and out of a company but does not specifically delineate the availability of cash for capital providers in the way that FCFF does. Therefore, FCFF provides the most relevant metric for understanding the cash flow landscape available